Amazon´s Next Disruptive Move
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Amazon (NASDAQ: AMZN) has enjoyed a polemic tax advantage over brick and mortar retailers for many years, but those times seem to be coming to an end due to budget deficits and lobbying efforts by brick-and-mortar competitors. And that could be a reason for concern for Amazon investors. A more insightful look at the issue, however, points to a change in strategy by the online retail giant that could make it an even more disruptive force in the retail business.
Tax laws mandate that online retailers collect sales tax in states where they have a physical presence, with the tax responsibility falling to the end consumers themselves. As a result, Amazon currently collects sales tax in a handful of states where it maintains a physical presence, which gives it cost advantages in many of the geographies where it operates.
Due to mounting political pressures and fiscal needs, many states have passed laws that aim to force Amazon to collect sales taxes by broadening the definition of what it means for a company to have a physical presence in the state. Amazon has traditionally fought against those changes aggressively; the company filed numerous legal challenges, and fired all of its marketing affiliates in Colorado, North Carolina, Rhode Island, and California.
But suddenly, Amazon has stopped fighting the sales-tax war. Last fall it dropped its repeal campaign in California and instead signed a deal with lawmakers to begin collecting sales taxes later this year. That was followed by several more tax deals—over the course of the next couple years, Amazon will begin collecting sales tax from residents of Nevada, New Jersey, Indiana, Tennessee, Virginia, and on July 1, it began collecting taxes from Texans.
Sales taxes would mean higher prices for Amazon, eroding in part some of its most important competitive advantages. So why would Amazon so easily give up its fight in the sales tax war?
Maybe the company has finally realized that it doesn't stand a big chance of winning that war, and, perhaps more importantly, there are some important upsides in collecting sales taxes and in terms of the geographical presence of its warehouses.
In agreeing to collect those taxes, the company can legally set up warehouses in some of the largest cities, which would give Amazon the possibility to provide same-day delivery in its most important markets. Amazon is not only investing heavily in new warehouses, the online retailer seems very focused on distribution efficiency through various innovations -- this year it purchased Kiva Systems, a company that makes amazingly effective robots to improve shipping times and overall logistics efficiency.
Amazon is willing to lose some of its price advantage in order to gain speed and efficiency in delivery. Is that a smart strategy?
I think it is. First of all, Amazon can still be very competitive in price due to its enormous scale and operating efficiencies, and same-day delivery reduces a big disadvantage Amazon has in its competition against traditional retailers: the instant gratification effect.
When you buy something at Wal-Mart (NYSE: WMT) or Best Buy (NYSE: BBY), you get out of the store with the purchased item in your hands. Amazon, on the other hand, makes its customers wait to receive the products, and that's a big drawback for some customers or some particular products.
There are big differences in how Amazon has affected these two businesses, however. Wal-Mart shares are trading near all-time highs on the back of strong results for the gigantic retailer, while Best Buy has lost more than 40% of its value during the last two years as the company faces collapsing profit margins and lackluster sales.
Electronics have become a commoditized business, and many people just test the products at Best Buy and then place an order through Amazon to get those products home delivered at lower prices. Wal-Mart has bigger scale and cost efficiencies, and some products like groceries are not prone to be sold online. These differences between Wal-Mart and Best Buy show how disruptive Amazon has been over the last years for the retail industry. It's not that retail is dying, Amazon is killing some competitors.
There will certainly be an extra cost in building all these warehouses and providing a fast delivery service. Will Amazon translate those costs to additional revenue or is the company planning to absorb that impact? The second alternative sounds more likely, at least at first.
Traditionally, Amazon thinks about providing a valuable product or service first, and profit margins take the back seat in consideration. That's why it has embarked in ferocious price discounts and launched products like Kindle, which the company sells at razor thin margins, or perhaps even at a loss.
This kind of strategy makes it hard for investors to project earnings or analyze the company's valuation, but on the other hand, it's a characteristic Amazon shares with arguably the most successful tech company of the last years: Apple (NASDAQ: AAPL).
It may sound like a strange idea considering that Apple has operating margins near 36% and Amazon is in the 1.4% zone. But both companies share the same philosophy when it comes to planning their next moves: considering what would be a great product –or service – first, and then trying to profit from it.
Apple is selling as many iPads and iPhones as it can build, and for that reason it makes little sense for the Cupertino company to reduce prices. But Amazon is a retailer, and low prices are a big part of its added value. Having to choose between lower margins or higher prices to its clients, Amazon is more likely to pay the extra cost of same day delivery from its own pocket.
If Amazon manages to materially shorten its delivery period, implementing same-day delivery at low or no cost for its customers, the instant gratification effect can be even more powerful when shopping in Amazon than in traditional brick and mortar retailers. Customers don't need to go to the store or wait in line to buy something through Amazon. If they can get home delivery in a matter of hours for a competitive price, there are some really good reasons to consider Amazon a better alternative for many goods.
Amazon is losing its tax advantages, and that will have a negative effect on its pricing. But at the same time, it frees the company to expand its same-day delivery service to masses of customers, which could ultimately be a very smart move by the company.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, and Best Buy. Motley Fool newsletter services recommend Amazon.com and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.